Dollar General hurt by deflation, Wal-Mart and food-stamp decline

Dollar General Corp.’s disappointing results Thursday can be attributed to a few factors, including deflationary forces, a decline in food stamp benefits, and, according to analysts, price investments from Wal-Mart Stores Inc.

Dollar General
DG, -0.31%
expanded its analysis of the impact of deflation beyond the “commodity cost of milk and eggs… to average unit retail price deflation,” said the company’s chief executive, Todd Vasos, on the Thursday earnings call, according to the FactSet transcript. The company found that the impact was greater in the third quarter than the second.

“We estimate that the combined headwinds from the average unit retail price deflation and reduction of SNAP benefits negatively impacted our same-store sales for the third quarter by approximately 150 to 175 basis points and for our second quarter by approximately 100 to 115 basis points,” said Vasos. SNAP refers to the Supplemental Nutrition Assistance Program, which is the government’s food stamp program.

Dollar General says it made price investments in approximately 450 items in about 17% of its store base during the third quarter. To improve store traffic and market share, the discount retailer made investments in labor and marketing in select areas as well.

“[W]hile some of the third-quarter investments resulted in a desired performance, others did not,” said Vasos. “For instance, we invested in incremental promotional activity to drive traffic although results were mixed and did not meet our overall expectations.”

Dollar General reported earnings per share of 84 cents, down from 86 cents last year and below the 93-cent FactSet consensus. Sales were $5.32 billion, up from $5.07 billion last year but missing the $5.36 billion FactSet estimate. Same-store sales were down 0.1%, also missing the FactSet consensus for a 0.6% increase.

Dollar General shares closed Thursday down 5%, but had been down as much as 8.7% at the intraday low.

In October 2015, Wal-Mart
WMT, -1.58%
outlined a multibillion-dollar plan to improve business results. The third-quarter challenges Dollar General faced were heightened by Wal-Mart’s price investments, included in that strategy.

“The deflationary push has been exacerbated by a sharper focus on price by Walmart, which has a reasonably strong customer overlap with Dollar General – slightly more so than it does with Dollar Tree
DLTR, -0.13%
” said Håkon Helgesen, retail analyst at Conlumino. “Notably this overlap has been increasing over the past six months, suggesting that Walmart has managed to capture some spend of Dollar General’s customers.”

Dollar General could become “more of a target for mass merchants and grocers looking to boost volumes,” Helgesen said, which could lead to same-store sales and margin erosion.

Analysts at The Buckingham Research Group are also concerned about Dollar General’s margins.

“Longer term, we would like to understand how management is thinking about its margin structure and whether it is willing to follow Wal-Mart down the path of giving up margin and profitability to try to drive sales,” analysts wrote in a note published Thursday before the conference call.

Buckingham Research rates Dollar General shares buy with a $90 target price.

On the call, Dollar General’s Chief Financial Officer John Garratt said the company is still budgeting for 2017, so the company wouldn’t provide any updates. However, it is optimistic based on what it has seen so far.

“[I]t takes a little time for these price investments to take hold with the consumer but the great thing is as we move through Q3, we saw unit transactions and sales starting to build momentum,” Vasos said. “And actually, as we exited Q3 and enter Q4, we even saw a further acceleration of that, whereas we have actually crossed over where we’re now returning pretty nicely on our investment.”

Dollar General shares are up 2.2% for the year so far while the S&P 500 index
SPX, -1.54%
is up 7.2% for the same period.

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